Inheritance tax and the spouse exemption: Should it be extended? – Marilyn McKeever

by | Aug 2, 2022

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Written by Marilyn McKeever, partner at law firm BDB Pitmans

Inheritance tax (IHT) is probably the most hated tax. It is payable on savings out of taxed income and takes a sizeable chunk out of the inheritance an individual can leave to their family on death.

Nor is IHT a big revenue raiser. In 2021-22, the tax raised £6.1bn: a measly 0.85% of the total tax revenues of £718.2bn and 1.5% of the income tax take.

A quick summary of exemptions and reliefs

As a reminder, outright gifts to individuals are tax free provided the donor survives for seven years (but taxable if they don’t). Gifts to trusts for young or vulnerable beneficiaries are problematic as they incur up-front and ongoing tax charges.

Whilst the very wealthy can afford lifetime gifts, the majority of most people’s wealth is tied up in their house and pension scheme and their scope for gifts is limited.

The first slice of everybody’s estate is tax free. The “nil rate band” is still £325,000, a figure set in 2009 and frozen ever since, bringing many estates into the tax net through fiscal drag.

A person who owns, or has owned, real estate and leaves it to their children or grandchildren by will gets an extra residence nil rate band of £175,000, but this tapers away if the total estate exceeds £2m.

The nil rate bands can be transferred to a surviving spouse/civil partner so the survivor can leave £1m IHT free to their children or other beneficiaries.

Other people can give a maximum of £500,000 tax free. Anything else is taxed at 40% unless a relief applies.

The main IHT reliefs are as follows:

· Businesses and farms are generally tax free;

· Gifts to charities are exempt;

· Regular gifts made out of surplus income are exempt without limit (lifetime only); and perhaps most important of all

· Gifts between spouses and civil partners (“spouses”) are exempt without limit. (unless one spouse is non-domiciled).

Might the spouse exemption be extended?

There have been attempts!

It is not uncommon for siblings to share a house or flat. The property may be the main asset of their estates and its value may well exceed the nil-rate band, especially if it is in London or the south east. On the first sibling’s death, the survivor may have to sell the property to pay the inheritance tax, losing their home at a time when they are most vulnerable. The elderly Burden sisters were in this

situation. In 2008 they argued in the European Court of Human Rights that they should have the same protection from inheritance tax as a married couple. The Court, rejecting the claim, accepted the UK government’s argument that the purpose of the exemption was to promote “stable, committed heterosexual and homosexual relationships by providing the survivor with a measure of financial security after the death of the spouse or partner“. The Court recognised that there could be hardship in some situations, but it was for the government to decide “how best to strike the balance between raising revenue and pursuing social objectives.” Essentially, it is a question of policy.

The Office of Tax Simplification (OTS) also addressed the issue in its 2018 Reports on Inheritance Tax, observing that cohabitees were in the same position as siblings. The OTS concluded:

“The OTS considers that any change to the definition of spouse to include a cohabiting partner or siblings would be far reaching. This would most naturally form part of a wider response to social change considered across government rather than being driven primarily by Inheritance Tax considerations.”

HMRC’s figures for the 2019-20 tax year show that the cost of the spouse exemption to the exchequer was £1.83bn. HMRC comment that the actual cost is substantially higher than this because not all estates need to provide full details. Even on these figures, the cost of the relief is approximately one third of the total IHT revenue, so the government is likely to be reluctant to extend it, whether to cohabitees (who have the option to marry/enter civil partnerships) or siblings, who do not.

Despite this, Lord Lexden has just introduced a Private Member’s Bill into the House of Lords seeking to extend the exemption for gifts between spouses to siblings who have lived in the same household for seven years.

The Bill would exempt gifts from one sibling to another of any property, during lifetime or by will.

This goes beyond the problems identified as arising on the death of a sibling and it seems unlikely that the government will have much sympathy for the proposal.

Conclusion

Nothing is certain except death and taxes, and in the case of inheritance tax, they often coincide! With proper planning, it is possible to help your clients to mitigate the impact of IHT and the sooner people seek advice the better.

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